Ravindra Rao, VP - Head Commodity Research at Kotak Securities
Commodities traded largely lower this week as market players chose the US dollar amid positioning for the Fed decision next week. Increasing uncertainty about the Chinese economy and the Russia-Ukraine conflict also affected commodities.
Gold slumped to 10-week low before bouncing back to $1,900 per troy ounce level, reflecting the move in the US dollar; industrial metals traded largely lower on weaker risk sentiment and concerns about health of the Chinese economy, however, prospect of China's stimulus measures kept a floor to prices; Crude oil and natural gas managed to gain this week on supply concerns relating to Russia.
The US Fed is scheduled to meet on May 3-4 and the general market expectations is that the central bank may raise the interest rate by 0.5 percent. Hawkish comments from Fed officials and higher inflation has fuelled expectations that the Fed may raise the interest rate aggressively to curb rising prices. The Fed usually changes interest rate by 0.25 percent but may consider bigger move to get interest rate closer to normal levels.
The Fed's rate hike at the upcoming meeting has been factored in and market players are now trying to assess future stance. With the Fed's emphasis on getting inflation under control, there is a high possibility that the central bank may indicate more rate hikes over next few months.
The US central bank's tightening expectations however got a jolt from the GDP data. The US GDP fell 1.4 percent in Q1 as against a forecast of 1.1 percent growth. The economy grew at a robust 6.9 percent pace in the fourth quarter. The unexpected contraction shows that the economy was stressed by rise in virus cases, rising price pressure and geopolitical tensions.
Apart from the Fed’s tightening expectations, the US dollar has also benefitted from the cautious stance of other central banks. The Japanese Yen slumped to a fresh 2002 low this week as Bank of Japan maintained support for accommodative policy despite raising inflation forecasts. The central bank said it would conduct daily purchases of 10-year bonds at a yield of 0.25 percent, showing no willingness to let bonds trade in a wider band.
The US dollar index jumped to December 2002 high this week post Bank of Japan decision as it further highlighted that Fed may lead other central banks on monetary tightening. The US dollar index however shed some of the gains post US GDP data.
Apart from Fed's tightening outlook, commodities struggled also amid concerns about health of Chinese economy. China is struggling to bring the virus outbreak under control while virus related restrictions are hurting economic activity. Market concerns eased somewhat as Chinese authorities promised more measures to support the economy. China plans to use monetary policy tools, boost infrastructure spending and support housing market.
The Russia-Ukraine war also came into focus as Russia cut natural gas supply to Poland and Bulgaria over their hesitance to make gas payments in rubbles. Russia's move highlighted that energy supply risks are far from over. Market players are now trying to assess if European Union may take measures to restrict Russian energy exports to the region. Germany has already expressed support for phased in ban on Russian crude exports.
Commodities have already corrected on expectations that Fed may raise interest rate next week and further move will be dependent on Fed's future stance. Fed is largely expected to maintain hawkish stance however if the central bank acknowledges risks to the economy, it may also be enough to cause some profit taking in US dollar. Apart from Fed, focus will also be on Bank of England. BOE has been raising interest rate since December and is expected to further hike by 0.25 percent next week. Currency movement will be dependent on BOE's stance on future hikes as well as balance sheet reduction.
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